European Union pension funds could be €1.4 billion (£1.3 billion) worse off every year if new rules for hedge funds and private equity firms are approved.

The EU’s draft directive on alternative investment fund managers will allow pension schemes to invest only in hedge and private equity funds that are domiciled in the same region.

The EU is seeking to bring greater regulation to industries that it regards as having been instrumental in the financial meltdown.

Pension funds would be prohibited from investing in 40 per cent of all hedge funds and 35 per cent of all private equity funds, reducing their investment options and pulling down their returns, according to a report carried out for the Financial Services Authority (FSA), the City regulator, by Charles River Associates, the Boston consultancy.

EU pension funds have about €5,000 billion under management and more than half of them invest in alternative investment managers, according to Charles River.

The consultancy calculates that the directive will lower the funds’ returns by 0.05 per cent a year, or €1.4 billion.

Richard Lambert, the CBI’s Director-General, yesterday called for an amendment of the draft directive.

“We are concerned that these proposals could limit the choices available to investors, including pension funds, by restricting the use of non-EU domiciled funds,” he said.

“This could reduce investment returns, making it harder for people to pay for retirement, worsening deficits in pension schemes and requiring higher pension contributions from employees.”

Dan Waters, the FSA’s head of asset management, added: “We see those one-off costs — they are very significant and we do not think they can be justified.”

The draft directive will also impose a one-off €3.2 billion compliance cost on the alternative investments industry, as funds will need to limit leverage, implement new legal structures and submit detailed data.

There would also be continuing annual compliance costs of about €311, the Charles River report added.

The EU is working on an updated draft of the directive, expected to be published by Christmas.

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